Trading Penny Stocks and What You Should Know

We all know that penny stocks are a high risk investment, but they offer some of the richest rewards available on the stock market. Home runs and massive gains are achieved each and every day in the small cap stock arena. You must preserve capital and at some point be willing to cut your losses.

SHORT TERM TRADING

Each and every day, there are several hot penny stocks in play. However, sometimes less is more. First and foremost limit your number of positions to a maximum of three stocks. It’s hard enough to pay attention to one stock, nevertheless five or six.

MARKET MECHANICS

Investors also need to understand the way the market works. You must understand the difference between the bid and ask. This is especially important with penny stocks. The person who is bidding for the stock is willing to buy the equity at that specific price. The scenario is flipped in regards to the ask price. The person who is offering the stock for sale is willing to sell the equity at that exact price.

LIMIT ORDERS

Human nature sometimes takes advantage of us and we can get real greedy. When a penny stock is moving, our greed tells us to act quickly.  More often than not, when you place a market order on a hot penny stock your execution price is much higher than you initially expected. This is why it’s better to stay disciplined and miss a potential massive gain than expose yourself to a bad fill and a potential disaster. Another common mistake made while investing in penny stock investors is putting your money with illiquid stocks. Owning a stock that doesn’t trade much before everybody catches on is great when it goes up, but there could be hell to pay if you are wrong. Having no buyers ready to buy your illiquid position can wipe out hard earned gains from other positions. So try to stick to stocks that trade at least 100k in dollar volume per day.

SCALING OUT

When investing in penny stocks you should have an exit strategy. Actually, it doesn’t matter if it’s a blue chip or a penny stock.  You should always have an exit strategy on any investment.  You need to know how and when to get.  You should set a threshold for how much money you are willing to lose, whether it is 5 or 10%.  If your pre-determined loss threshold is hit, you should chalk it up as a loss and move on.  Another good penny stock idea will come along sooner than you think. Most experienced traders never let their whole position go at once. Scaling out of positions in thirds is a common trading strategy. Scaling out may cost more in commissions, but paying a little more is worth it when implementing a sound strategy.

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